Legal history before passing SARFAESI Act

01: After nationalisation of banks in 1969 and 1980 the menace of private lenders came down since the banks achieved phenomenal geographical growth. Even though, it was impressive quantitative achievement, the banks suffered financial losses year after year due to low efficiency, productivity, bad portfolio performance and eroded profitability. The public sector banks faced several constraints for survival in the map of the banking industries.

02: Statutory Liquidity Ratio (SLR) {as per Sec.24(2A) of Banking Regulation Act} and Cash Reserve Ratio (CRR) {as per Sec.42 (1) of RBI Act} were required to be maintained at higher percentages i.e. SLR @ 38.5% and CRR @ 3 to 15%. Due to higher percentages of SLR and CRR the operational freedom of the banks was curtailed. The SLR, which was 25% in 1964-65 was increased to 38.5% and the CRR, which was 3.5% in 1962-63 was increased to 15% in 1989-90 and in 1990-91. Compliance of SLR & CRR requirements is mandatory. The banks were depending upon ‘brokers in the share market’ for arranging call money deposits to meet the above statutory requirements. In turn the brokers were availing favour from the banks for overdraft facilities or for collection of high value instruments pertaining to securities transactions with other banks (including private/foreign banks). Scam in securities surfaced in 1990-91 and unearthed the secret of sham transactions, where, in fact, no physical transfer of securities took place. Special Courts have been established for tying these security scam cases. Many public sector banks were involved in these claims merely because they have either collected high value cheques presented by the brokers or issued high value banker’s cheques/pay orders at the request of the brokers by debiting their accounts maintained in PSBs.

3: Added to the above problems, monies lent by Banks/FIs were blocked up in the hands of unscrupulous borrowers. The then existing legal system was not adequate for early recovery of the debts from the defaulting borrowers. Due to this reason the foreign investors were afraid of investing their funds in India. The adjudication process of claims before civil courts consumed time and the borrowers were taking advantage of the same. Meanwhile hypothecated movable secured assets vanished due to vagaries of weather or diminished in their value on passage of time. The advances were defaulted and Non Performing Assets (NPAs) accumulated as mountain and remained as unproductive assets in the books of the banks. Banks were maintaining these NPAs incurring provisions from profit. Credit is main and continuous  activity of banks for earning interest income. If a banks is not able carry on the credit activity continuously, then, it has to close down its shutters. In the past some banks faced ‘credit crunch’ and were not able to meet the requirements of the needy borrowers. Some banks have also borrowed funds from RBI for survival in the map of banking industries.

4: In 1990-91 when the scam in securities surfaced, Government of India constituted Narasimham Committee (headed by Sri. M. Narasimham former Governor of Reserve Bank of India (RBI), to review and suggest the aspects relating to structure, organisation procedures for functioning of the financial system. Narasimham Committee laid down a foundation to reform the Indian banking sector. Therefore this committee is also called as Banking Sector Reforms (BSR) Committee. The BSR committee pointed out that, lack of competitiveness, vis-à-vis global standards, low technological level in operations, overstaffing, high NPAs and low level motivations, higher rate of SLR & CRR, directed credit programmes, political and administrative interference, subsidising credit, mounting expenditure of banks were some of the causes which have shackled the performance of banking sector in the country. The committee vide its report made in 1992 recommended for reduction of rates of SLR & CRR, phasing out of directed credit programmes and introduction of priority sector; stipulation of minimum Capital Adequacy Ratio (CAR) by March 1996; adopting uniform accounting practices with regard to income recognition, asset classification and provisioning against bad and doubtful debts; setting up of special tribunals for speedy recovery of debts, setting up of ‘Asset Reconstruction Funds’ for takeover of bad and doubtful debts; abolition of branch licensing; allowing foreign banks to open their offices in India; autonomy to banks to recruit officers; revised procedure for selecting Chief Executives and Board of directors in public sector banks; speedy realisation of capital markets; enactment of separate law for mutual funds including laying down of prudential norms for mutual funds. 

5: Based on the Committee’s recommendations, RBI introduced prudential norms relating to income recognition, asset classification and provisioning in advances portfolio with effect from 31.03.1993. Prior to this, the banks were following the “Health Codes” for advances. With the introduction of the RBI’s prudential norms, the Health Code system and all the related reporting requirements, etc. under the Health Code system ceased to be a subject of supervisory interest.

6: Performance in terms of profitability has become the benchmark for the banking industry like any business enterprise. In particular, the problem of non-performing asset (NPA) was not considered seriously in India in the post nationalization (of banks) period. However, with the financial sector liberalization drive, this issue has been taken up seriously by introducing various prudential norms relating to income recognition, asset classification, provisioning for bad assets and assigning risks to various kinds of assets of a bank.

7:  In 1993 Parliament passed Recovery of Debts Due to Banks & Financial Institutions Act and the claims of the banks and financial institutions involving ten lakhs and above came to be separated and brought within the fold of the said RDDB & FI Act 1993 for adjudication by the Debts Recovery Tribunals established across the country. But there was no speedy recovery of debts by the Banks and Financial Institutions through the tribunals as adjudication process was consuming time and this situation had crippled the viability of strength the banks and financial institutions. However, the performance of DRTs was shackled because of various impediments. One of such impediments was automatic operation of stay under Sec 22 of Sick Industrial Companies (Special Provisions) Act (SICA) on making reference to ‘Board for Industrial and Financial Reconstruction’ (BIFR) created under article 4 of SICA by the borrower’s industrial entity. Consent was required from the BIFR, for the process of recovery. Leave of BIFR was not an easy task for banks once reference is registered with it. Banks found it extremely difficult to sue such borrowers (industrial entities) for recovery of money against an industrial entity registered as "sick" under SICA. Thus performance of PSBs continued to be adversely affected, partly as a result of pending references with BIFR, partly because of the adjudication process which was consuming substantial time to reach execution stage, partly because of the delicate political economic structure of India, partly because of competition from foreign banks, and partly because of inherent structural deficiencies. Government of India, again requested Narasimham Committee, to review progress of banking and financial sector reforms to strengthen financial system and suggest methods to make it internationally competitive.

8: The Banking Sector Reforms (BSR) Committee submitted another report in 1998. The important recommendations of the BSR Committee are:  1). A minimum target of 9% Capital Risk-Adequacy Ratio (CRAR) to be achieved by the year 2000. The ratio should be raised to 10% for the year 2002; 2). A risk weight of 5% for market risk for government-approved securities should be attached; 3). An asset to be classified as doubtful if it is in the category of 18 months in the first instance and eventually for 12 months and loss if it has been so identified but not written off; 4). Income recognition, asset classification should apply to government advances; 5). The minimum shareholding by government/RBI in the equity of nationalised banks and SBI should be brought down from 51% to 33%; 6). Inter alia the BSR Committee recommended bank mergers; 7).The urgent need to bring reforms in the existing legal system  for speedy recovery of the debts of the banks and financial institutions; Rehabilitation of weak Public Sector Banks (PSBs) with high percentage of NPAs (20% NPAs of total loan assets); 9).Establishment of small local banks (at rural and district and State level) to cater to the needs of customers in the country;10).Experiment with concept of narrow banking for placing funds in less risky assets; 11). Creation of global sized banks; 12).Review and updating of laws relating to banking; 13).Raising of capital adequacy ratio to improve inherent strength of banks 14). Professionalising and depoliticising of bank boards; 15). Automation of Public Sector Banks for review of recruitment, training etc. are some more important recommendations of the Committee. The recommendations of the BSR Committee have been implemented in a phased manner.

9: To achieve these objectives various reform measures were initiated. Reduction in statutory pre-emption so as to release greater funds for commercial lending, interest rate deregulation to enable price discovery, greater operational autonomy to banks and liberalisation of the entry norms for financial intermediaries including reduction in SLR and CRR (which are mainly used to finance the fiscal deficit of the government and as tools of credit control and also to protect the depositors). Before 1991, interest rates, both on deposits and loans were controlled by RBI. With effect from October 1997 interest rates on all time deposits have been freed. Only interest rates on saving deposits remain controlled by the RBI. Similarly the lending rates were also freed in a series of steps. The RBI now directly controls only interest rates charged on exports. The rationale for liberalising interest rate in the banking system was to allow banks a greater flexibility and encourage competition. Banks have been given more autonomy by reducing government's stake in it as restoration of health of the banking system was recognised. Competition has been infused by allowing new private sector banks and more liberal entry of foreign banks (at the end of march 2001, there were 8 new private sector banks, 23 old private sector banks and 42 foreign banks as against 23 foreign banks in 1991). Various prudential norms relating to capital adequacy and risk weighted assets, income recognition, asset classification and provisioning for bad assets (NPAs) were introduced. The capital adequacy ratio was increased from 8% to 9% following the BSR Committee’s recommendation. Banks were allowed to close down loss making units and merging with other banks. Flexibility is introduced in resource mobilisation. Financial institutions are not required to seek RBI's approval for raising resources by way of bond / debentures (by public / private placement). In order to have a coordinated approach in the recovery of large NPA accounts, as also for institutionalising an arrangement for a systematic exchange of information in respect of large borrowers (including defaulters  and NPAs) common to banks and Financial institutions, a Standing Committee was constituted in August 1999 under the aegis of Industrial Development Bank of India (IDBI). 

10: One of the important issues that drew attention of policy makers and researchers is the Non-Performing Assets of Commercial banks. High level of Non Performing Assets (NPAs) was a concern to everyone. As credit is very essential for economic growth and NPAs affect the smooth flow of credit, reforms in legal framework, particularly for speedy recovery of debts of banks and financial institutions was suggested as a matter of urgent need.

11:  Therefore in 2000 Andhyarjuna Committee (headed by Mr. T.R. Andhyarjuna Former Solicitor General Of India) was constituted by Government of India to suggest changes in the existing legal system. The Committee vindicated the need for enacting laws for speedy recovery of the debts due to the banks and financial institutions in line with State Finance Corporations Act 1951 for enforcement of security interest without interference of courts / tribunals so that the time consumed in the adjudication process could be curtailed. It recommended for enacting law conferring powers to banks and financial institutions as have been conferred upon ‘land development banks’ and ‘state financial corporations’ for taking possession and sale (private sale) of securities both movable and immovable) without the intervention of court for speedy recovery with proper safeguards. Such a special law would also define a charge by way of hypothecation, floating charge and crystallisation of the floating charge into the rights and obligations of the hypothecator and hypothecatee with power of sale without the intervention of the court to banks and financial institutions. The law should provide for the setting up of a new registry jointly by the banks and financial institutions for registration of mortgages and hypothecation charges in place of the present obsolete and dilatory office of sub-registrar of assurance which are presently keeping records of transfers.

12: Umerjee Committee ( headed by the former retired Executive Director of RBI ) framed the three in one Act and accordingly Parliament enacted SARFAESI Act 2002. This Act is very often called as Securitization Act whereas the third part of the Act (i.e. Enforcement of Security Interest Act) is never spelt out which is powerful tool for banks and financial institutions for quick and permanent elimination of NPAs from the books of accounts.

13: Constitutional validity of SARFAESI Act was challenged. Supreme Court in Mardia Chemicals Ltd v Union of India:(2004) 4 SCC 311  upheld the constitutional validity of the Act. Sec.17(2) of the Act is struck down as unconstitutional. Subsequent to this, and based on the verdict of Supreme Court in Mardia Chemicals’ case, the SARFAESI Act was amended on 11.11.2004. Another judgment of Supreme Court in (Transcore  Vs. Union Of India & Anr. : AIR 2007 SC712) has resolved several major ambiguities and the recovery position in NPAs today in all most all banks and financial institutions through action under the Act has improved to a greater extent compared to the previous years (2000-2007).The arms of the banks and financial institutions is strengthened by the SARFAESI Act.